Financial Update (First Quarter 2008)

Fed Seeks to Mitigate Foreclosures, Says Fed Governor Kroszner

Many factors have contributed to the rising number of foreclosures and early payment defaults on subprime mortgages, "but the role of abusive lending practices is of particular concern," said Federal Reserve Governor Randall S. Kroszner in a speech at the American Securitization Forum 2008 Conference in early February. "Such practices have led many people into homeownership that they cannot sustain, hurting their families as well as their neighbors and communities," he noted. These same practices have also undermined investor confidence, virtually shutting down the subprime market and making it more difficult for borrowers with shorter or weaker credit records to obtain home loans.

Acting now to prevent a wave of defaults
Kroszner pointed out the need to act quickly "to protect homeowners, communities, the mortgage market, and the economy from the adverse consequences of unnecessary defaults and foreclosures." In 2008, nearly 1.5 million adjustable-rate subprime mortgages are scheduled to have their interest rates reset—significantly more than in 2007. With so many borrowers facing higher payments and potential repayment problems, the mortgage industry must develop prudent loan modification programs and other assistance to help borrowers, Kroszner said.

"Loan-by-loan modifications can help some, but they require substantial time and effort," said Kroszner. He believes a systematic approach is needed that lets servicers reach troubled borrowers more quickly and prevent more foreclosures. He applauded the efforts already under way to streamline the refinancing and modification of subprime adjustable-rate mortgages, challenging mortgage servicers to reduce the constraints on capacity.

Protecting those most at risk
Kroszner also discussed the Federal Reserve Board's recent proposal for stricter regulations prohibiting abusive and deceptive practices in the mortgage market. While the proposal covers most mortgage loans with certain protections, it applies stricter rules for the entire subprime market and the riskier end of the "near prime," or "alt-A," market, focusing greater protections where the risks are greatest.

"The proposed regulations," Kroszner said, "are designed to protect consumers from excessive layering of risk even as the practices that increase risk may change." Risk layering refers to the complex ways that risk factors and underwriting practices can affect each other. The proposed regulation uses a loan's annual percentage rate, which is closely related to risk, to determine the threshold for stricter regulations, thus ensuring that the protections would cover loans with higher risks rather than single out particular risk factors or underwriting practices.